Greg Mankiw's Blog

Monday, December 31, 2007

The economic isolationists are winning

"Do you think the fact that the American economy has become increasingly global is good because it has opened up new markets for American products and resulted in more jobs, or bad because it has subjected American companies and employees to unfair competition and cheap labor?"

28 % of the American public said globalization is good, while 58 % said it is bad.

Note that even the pro-trade part of the question presumes a mercantilist approach to the issue. In actuality, trade is not primarily about more or fewer jobs but about allocating labor among industries toward those in which we have a comparative advantage. I doubt, however, that a more economically literate rewording of the question would have found the American public sympathetic to globalization.

Career Advice from David Brooks

One of the best pieces of career advice I ever got is: Interview three people every day. If you try to write about politics without interviewing policy makers, you’ll wind up spewing all sorts of nonsense.

Brooks was not talking about economists in particular, but this piece of wisdom can be taken as a critique of much of the economics profession. Many economists who write about policy rarely, if ever, encounter actual policymakers. Instead, they prefer to sit in the comfort of their ivory tower offices. (I know I do.)

I wonder how different the economics profession would be if economists were expected to do a year of service outside of academia or, at the very least, if university hiring committees rewarded a year of real-world experience as the equivalent of, say, a couple of academic publications. My conjecture is that the profession would be less creative but more useful.

Sunday, December 30, 2007

A Homework Problem from China

Chapter 9 of my favorite textbook presents the standard analysis of a tariff (a tax on imports) and shows that it reduces economic welfare as measured by the sum of producer surplus, consumer surplus, and tax revenue. Even though the tariff makes domestic producers better off and raises some revenue for the government, these gains are more than offset by losses to consumers, leading to a deadweight loss.

This news story suggests a good homework problem extending the analysis:

China, the world's biggest grain producer, will tax exports of wheat, corn and rice to increase domestic supply and control rising food prices. Exporters of wheat will start paying a 20 percent tax on Jan. 1, while the tax for corn and rice was set at 5 percent, the Finance Ministry said.

Draw the graph that describes the market for grain in an exporting country. Use your graph to answer the following questions.

How does an export tax affect domestic grain prices?

How does it affect the welfare of domestic consumers?

How does it affect the welfare of domestic producers?

How does it affect government revenue?

What happens to total welfare in China, as measured by the sum of consumer surplus, producer surplus, and tax revenue?

Friday, December 28, 2007

Krugman on Trade

Together with Larry Summers and Doug Elmendorf, I have recently become an editor of the Brookings Papers on Economic Activity. Our first conference will be held in the spring of 2008, and we have a blockbuster lineup. One of the papers is by Paul Krugman, who will be writing about trade and inequality. I was delighted to get Paul thinking about economics again, hoping the project might distract him from his compulsion to tell the world how much he hates Republicans. (In case you missed it, the answer is, A LOT.)

In today's Times, Paul gives us a hint about what his paper will be about. The column is well worth reading. He suggests that trade makes the United States richer overall but reduces the incomes of a majority of workers. In essence, he is saying that the gains from trade are concentrated at the top of the income distribution. That is certainly a theoretical possibility. The Times column, however, leaves that conclusion more as an assertion than as an established fact. Presumably, the Brookings Paper will give the numbers to back up the claim.

It seems to me that Paul is still struggling with the implications of this view. He concludes the column by saying, twice, that he is not a protectionist, but he also says that we should respect "those who are worried about trade." But what if those who are worried about trade are protectionists? Should we still respect them?

Tuesday, December 25, 2007

What my kids got for Christmas

Sunday, December 23, 2007

Damning with faint praise?

Of all the establishment economists, I like Greg Mankiw the best. Not because he isn't a statist and an inflationist and a centralist; but he has some knowledger of the Austrian School. He is a clear writer, and Joe Salerno tells me Greg's bestselling textbook is the least-bad of them all.

Larry is right: Comprehensive health care reform could lower government spending, much as lowering tax rates could increase tax revenue. Theoretically, many things are possible.

Raising the issue, however, makes it sound like Larry believes this outcome is likely. From my perspective, this is just wishful thinking. Debate over health reform typically centers around covering the uninsured. I doubt that this goal is going to be achieved with reduced government spending.

Some on the left want a single-payer system, which would in effect use the monopsony power of the state to reduce payments to suppliers of health products. But I would be surprised if Larry, with his generally sensible market-oriented views, favored those kind of health systems.

I wonder: Might this idea--that a tax cut can be financed by comprehensive health reform--become a new meme of the left? If so, I would encourage Larry to record this moment in intellectual history, perhaps by writing the theory down on a napkin.

Update: On my invitation, Larry responds:

Dear Greg--

Thanks for asking if I have any comment on your blog entry today.

I am flattered to see you following my internet chats so closely. You got me. The passage you quote is as you suggest technically accurate but misleading. It is very likely that at least for a long time comprehensive health care reform done properly would raise total government spending. Much as some might wish otherwise, there is no health care Laffer curve. The right answer to the question is that the increment to debt should be paid over time through whatever combination of spending and tax measures congress chooses and that in the health care space there is room for measures that would save money. My answer was much too telegraphic.

While we are on the subject of fiscal truths, I was a great admirer of the way the first edition of your textbook treated the idea that tax cuts could raise revenue. If I recall you used the word "charlatan" to describe economists who subscribe to this view. Such memorable language does not appear in subsequent editions. Does this reflect a) your view that you exaggerated the first time b) your changing you mind on the substance c) your view that the whole matter is uninteresting d) your concern that your readers do not know what a charlatan is e) your desire to make sure your book does not annoy charlatans who teach introductory economics?

Happy holidays.

Larry

The answer to Larry's question can be found here, where I write, "In the second edition of the text, I took out the phrase 'charlatans and cranks' because an editor and some readers of the first edition said (correctly) that it was too inflammatory for a textbook description of a policy debate. But the substantive analysis of tax policy stayed about the same. This old post includes an excerpt from the current edition."

"one of the most interesting things I've ever read"

Thursday, December 20, 2007

The Age of Turbulence

I just finished Alan Greenspan's memoir, and I highly recommend it. It includes a lot of good stories, and a healthy dose of economic wisdom. It is a perfect Christmas gift for that econonerd in your life. (I suppose, if you're reading this blog, someone should be giving the book to you.)

Summers on the Economy

Arrow on Climate Change

Tuesday, December 18, 2007

On Health Insurance Mandates

Some analysts, when discussing health reform plans, make a big deal over the issue of insurance mandates. They suggest that it is crucial to have mandates to solve the adverse selection problem and that plans without mandates will not work. Paul Krugman, for example, has given Barack Obama a lot of grief over exactly this issue.

The more I think about it, the more I come to the view that much of the rhetoric over insurance mandates is overblown. A mandate is only as effective as the penalty backing it up. No one, as far as I know, is ready to make failure to be insured a criminal act punishable by jail time. Instead, if a person fails to follow the mandate, he merely pays a penalty. So the mandate is really just a financial incentive to have insurance.

To continue with this logic, consider two proposals:

A person is required to have health insurance. If a person is in violation, he pays a $1000 fine. The revenue from the fines is rebated lump-sum to all taxpayers.

A person is not required to have health insurance, but those with health insurance receive a $1000 tax credit. The cost of the tax credit is financed with a lump-sum tax on all tax payers.

Notice that there is no economic difference between these two scenarios. The difference is purely semantic. In both cases, a person faces $1000 incentive to have health insurance. It does not matter whether we describe that incentive as a carrot (plan 2) or a stick (plan 1). The only real issue is the size of the incentive.

In fact, the administration’s proposal is very much like the Massachusetts mandate—in effect everyone would get a $7,500 or $15,000 deduction and the "punishment" for not getting health insurance would be to lose the deduction.

The Progressivity of the Income Tax

Sunday, December 16, 2007

Should a carbon tax be border adjustable?

Judy Chevalier considers what Washington should do about climate change if China does not play along:

The Tyndall Center argues that carbon reduction policies should focus on carbon consumption, not emissions. That makes sense, especially in the absence of a binding global agreement.

Applied to a carbon tax, this logic implies that the tax should be border adjustable. That is, a carbon tax would include a tax on imports from countries without a carbon tax based on the goods' carbon content and a similar tax rebate for exports. The policy would provide an incentive for Americans to reduce their carbon consumption, but it would not induce tradable goods industries to migrate toward nations without a carbon tax.

Bad Press for Ben

Thursday, December 13, 2007

Tax rates: Current vs Historical averages

A new CBO report gives the effective federal tax rate by income group. These numbers include all federal taxes, not just income taxes, and are expressed as a percentage of household income. (If you have questions about the CBO methodology, click here.)

The first number below is for 2005, the most recent year available. For comparison, I computed, and present in parentheses below, the average effective tax rate from 1979 to 2005, the time span covered in the report.

Notice that all groups are paying lower tax rates than the historical average. But in contrast to some popular perceptions, the change is not concentrated among the upper income groups. In fact, the opposite is true.

A Defense of Textbook Economics

Wednesday, December 12, 2007

How do the right and left differ?

The conclusion of today's ec 10 lecture:

In today's lecture, I have discussed a number of reasons that right-leaning and left-leaning economists differ in their policy views, even though they share an intellectual framework for analysis. Here is a summary.

The right sees large deadweight losses associated with taxation and, therefore, is worried about the growth of government as a share in the economy. The left sees smaller elasticities of supply and demand and, therefore, is less worried about the distortionary effect of taxes.

The right sees externalities as an occasional market failure that calls for government intervention, but sees this as relatively rare exception to the general rule that markets lead to efficient allocations. The left sees externalities as more pervasive.

The right sees competition as a pervasive feature of the economy and market power as typically limited both in magnitude and duration. The left sees large corporations with substantial degrees of monopoly power that need to be checked by active antitrust policy.

The right sees people as largely rational, doing the best the can given the constraints they face. The left sees people making systematic errors and believe that it is the government role’s to protect people from their own mistakes.

The right sees government as a terribly inefficient mechanism for allocating resources, subject to special-interest politics at best and rampant corruption at worst. The left sees government as the main institution that can counterbalance the effects of the all-too-powerful marketplace.

There is one last issue that divides the right and the left—perhaps the most important one. That concerns the issue of income distribution. Is the market-based distribution of income fair or unfair, and if unfair, what should the government do about it? That is such a big topic that I will devote the entire next lecture to it.

An Endorsement for the Height Tax

Our results, therefore, leave readers with a menu of conclusions. You must either advocate a tax on height, or you must reject, or at least significantly amend, the conventional Utilitarian approach to optimal taxation. The choice is yours, but the choice cannot be avoided.

Elite academics, including economists, seem to me to display a huge status-quo bias. All policies outside a certain range of familiar possibilities seem "silly" to ordinary people. So no matter how strong the supporting arguments, elite academics feel they must reject such proposals, so as not to seem silly themselves. Thus basically only eccentric academics, resigned to never becoming more elite, endorse such proposals. Since that describes me, let me state loudly and clearly: the economic theory is solid, so I support a revenue-neutral height tax as improving the status quo.

One Man, 20 Votes

Two Brown University economists have, for the first time, quantified the substantial effects of winning early in the race for the presidential nomination. In a National Bureau of Economic Research working paper, Brian Knight and graduate student Nathan Schiff demonstrate that voters in early primary states such as Iowa and New Hampshire have up to 20 times the influence of voters in later states in the selection of candidates.

Economists go for the GOP

Economists may not have picked a horse in the 2008 presidential race, but they do appear to prefer the Republican breed, according to the latest WSJ.com forecasting survey. Asked which presidential candidate would be best for the economy, only half responded but most threw their support behind Republicans. Thirty-five percent said Rudy Giuliani would be best, while 19% chose John McCain and 15% picked Mitt Romney. Hillary Clinton got the support of 8%, while John Edwards was the only other Democrat to register with 4% of the vote.

The Democrats would likely have done better in a survey of academic economists, whose views are somewhere between those of business economists and those of most other professors.

Interview with Maskin and Myerson

A New Member

Mayor Gavin Newsom plans to ask voters next year to approve a "carbon tax" on businesses that he says would provide a financial incentive for conserving energy and motivating workers to use public transportation.

The ballot measure would increase the city's 5 percent commercial utilities tax by an as-yet-undetermined amount to encourage energy-saving steps by hotels, offices and other nonresidential buildings, Newsom said in a recent interview with The Associated Press.

To keep the higher rates from becoming an economic drag on the city, the initiative would carry a corresponding decrease in the 1.5 percent payroll tax on for-profit businesses in San Francisco, according to the mayor.

Top earners have captured the big share of all income and wealth gains during the last three decades. They’re where the money is. If we’re to pay for public services they and others want, they must carry a disproportionate share of the tax burden.

The first two sentences are correct statements of fact. The third sentence appears to draw a positive inference from them. Interpreted as such, the sentence is just wrong. Is there any reason to think it is impossible for the government to raise adequate revenue with a proportional tax? Not that I know of, and the article gives no indication of why Frank might think otherwise.

Maybe Frank meant to write "should" rather than "must." In that case, the sentence would have conveyed a personal political opinion, rather than suggesting (incorrectly) a conclusion of economic science. It would have been more clearly labeled as a normative statement.

Friedman on Clark

Saturday, December 08, 2007

The height tax gets noticed

In its annual "Year in Ideas" issue, the NY Times Magazine draws attention to my height tax paper with Matthew Weinzierl. The summary is crisp and fair.

The Times also quotes a critic:

Peter Diamond, an economist at M.I.T., says the paper’s basic mistake is the notion “that if you can draw a silly inference from an approach, then that discredits a model.” He comments: “I think there is probably no model that passes that test."

I wonder what Peter's alternative approach is. If economic theorists are allowed to embrace inferences from a model that they like and cavalierly reject those that they consider "silly," what is the point of theory? That discretion gives the theorist the freedom to always confirm his priors. The economist ends up using theory like a drunk uses a light post--for support rather than illumination.

It seems to me that if you are going to reject a logical inference from a model, you have to explain why. That is not so easy for a height tax, which is precisely the point of the paper.

A Reading for the Pigou Club

Judged by the principle of intertemporal Pareto optimality, insecure property rights and the greenhouse effect both imply overly rapid extraction of fossil carbon resources. A gradual expansion of demand-reducing public policies – such as increasing ad-valorem taxes on carbon consumption or increasing subsidies for replacement technologies – may exacerbate the problem as it gives resource owners the incentive to avoid future price reductions by anticipating their sales. Useful policies instead involve sequestration, afforestation, stabilization of property rights and emissions trading. Among the public finance measures, constant unit carbon taxes and source taxes on capital income for resource owners stand out.

"In the Hamptons"

The Limits of Egalitarianism

It's not fair, he said. The beautiful people get all the breaks. Beauty is a natural advantage and he wants the good-lookers to be taxed to finance compensation for the ugly people.

A good topic for class discussion: What are the limits of government redistribution to achieve egalitarian goals?

A utilitarian might try to argue that while the utility of ugly people is lower on average, their marginal utility of income is no different, so there is no reason to redistribute based on beauty. If, however, beauty is correlated with income, which it is, then like height, it should be taxed, even according to the logic of utilitarianism. Moreover, a social planner with egalitarian preferences (that is, who has a social welfare function that is concave over individual utilities) would want to further tax the beautiful to compensate the ugly in order to equalize, at least somewhat, the levels of utility.

Most people would reject a beauty tax as absurd, which only goes to show that that most people do not share the moral sentiments often assumed in the economic literature on optimal tax policy.

Larry Summers vs John Snow

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Tuesday, December 04, 2007

Is comparative advantage obsolete?

In a new interview with the FT, Hillary Clinton invokes Paul Samuelson and says we live in a brave new world:

We have benefited through most of the 20th century from trade. It has helped to raise American standards of living, it has helped to create jobs. And I agree with Paul Samuelson, the very famous economist, who has recently spoken and written about how comparative advantage as it is classically understood may not be descriptive of the 21st century economy in which we find ourselves.

I believe that Senator Clinton is referring to Paul's paper in the Journal of Economic Perspectives.

I am deeply impressed by the Senator's reading list, but I hope her advisers also give her some of the responses to the Samuelson piece. For example, here is an excerpt from Mankiw and Swagel (free version):

Paul Samuelson's (Misdirected) Salvo against Outsourcing

Outsourcing surged back into the news in the period just before the election [of 2004]. In part, this reflected the intense focus on the issue in democratic campaign ads in the battleground industrial states such as Ohio. An additional focus of coverage on outsourcing followed a September 9, 2004 article in the New York Times that reported on a remarkable new paper by Nobel Prize-winning economist Paul Samuelson that purported to cover outsourcing. The article in the Times informed readers that:

In an interview last week, Mr. Samuelson said he wrote the article to "set the record straight" because "the mainstream defenses of globalization were much too simple a statement of the problem." Mr. Samuelson, who calls himself a "centrist Democrat," said his analysis did not come with a recipe of policy steps, and he emphasized that it was not meant as a justification for protectionist measures.

BusinessWeek (December 6, 2004) well summarized many people’s (mis)interpretation of the Samuelson article:

So unprecedented, so colossal, and so fast is this change [in the world economy] that eminent economists such as Paul A. Samuelson are beginning to question the basic tenets of free-trade theory. Is it possible that David Ricardo's economic analysis doesn't work for the 21st century? Can the theory of comparative advantage operate when China and India compete not only with low-cost labor but also with highly educated, highly skilled workers who have access to broadband and the Internet? What is the U.S. supposed to specialize in when Asia competes across the board in manufacturing and services in both low-end and high-tech jobs? Is the future prosperity of America in jeopardy?

BusinessWeek answered the final question in the negative, but many with the opposite view embraced Samuelson’s contribution as intellectual support, without understanding what it really said. The headline of the Pittsburgh Post-Gazette on September 23, 2004 put the reaction succinctly: “Nobelist Samuelson says Outsourcing May Not Be a Plus.”

Samuelson’s paper, which was eventually published in the Summer 2004 issue of the Journal of Economic Perspectives, showed that technical progress in a developing country such as China had the potential to reduce welfare in the United States. As the above quotations illustrate, outside the economics profession, this work was viewed as providing a rebuttal to those who had claimed that trade, globalization, outsourcing, and related phenomena would benefit Americans. The idea that this was a rebuttal appears to have been spurred by Professor Samuelson himself in discussions with journalists (as recounted in turn to us). The actual point of the paper, however, was that changes in China that led to less trade would lower U.S. welfare—a development that came about because the United States was losing some of the benefits it derived from free trade in the first place!

As explained by Bhagwati, Panagariya, and Srinivasan (2004) and in more detail by Panagariya on his website, Samuelson’s paper involved three stages. First, starting from autarky, China and the United States open up to trade and experience the usual benefits of trade based on comparative advantage. Second, China has a productivity gain in its export good, which improves the U.S. terms of trade and further benefits the United States. Samuelson’s third stage (or second “Act” as he put it) involves a Chinese productivity gain in its import good. This narrows the differences between the countries and thus reduces the scope for trade, potentially so much that all trade disappears. As trade diminishes, so too do the gains from trade.

As Panagariya points out, the potential for productivity changes to reduce the gains from trade has long been understood (Panagariya has Harry Johnson teaching this at the University of Chicago in the 1950’s). The harm in Samuelson’s setup comes from having less trade, not more. This is light-years removed from the usual concerns of people about globalization giving rise to too much economic integration, not too little. Dixit and Grossman (2005) further point out that the U.S. terms of trade if anything have improved since 1990, rendering moot even Samuelson’s theoretical scenario. And in any case, all of this has nothing to do with outsourcing, despite strained interpretations of such by Samuelson.

The underlying substance was largely lost in media discussions of Samuelson’s paper. One possible reason is that the Journal of Economic Perspectives published Samuelson’s cryptic paper by itself and then the explanation and gentle rebuttal by Bhagwati, Panagariya, and Srinivasan only later, in the Fall 2004 issue. This issue of the journal, however, came out after the November election, when media attention to outsourcing had fallen off from the pre-election peak.

Schumpeter

Monday, December 03, 2007

Principles of Economics, Rap Version

Autism and Economics

After reading a previous post, a father (who happens also to be an economist) registers a complaint:

Greg,

I enjoy reading your blog. But I have a complaint today.

I am not one of those who is perpetually offended by incorrect words or descriptions. In fact, I find most such people to be petty totalitarians-in-training.

I did do a full stop, however, when I ran into the phrase "post-autistic economics." As the father of two daughters with autism, it strikes me as a particularly odious phrase.

People with autism have enough difficulties without having their problems used as a punchline by intellectuals.

I fully understand that you did not invent the term, but a word of reproach for its inventors might be in order.

Thank you.[name withheld]

The French students who coined the term "post-autistic economics" chose it because they feel that mainstream economists share some of the deficiencies associated with the condition of autism. But I agree with the letter writer that use of the term indicates a lack of empathy and understanding for those who live with actual, severe autism.

Addendum: For those interested in the topic of actual autism, let me recommend the book A Different Kind of Boy, written by economist Daniel Mont about his autistic and mathematically gifted son Alex. It may be the most moving book I have ever read written by an economist. I also recommend the novel The Curious Incident of the Dog in the Nighttime, which is written in the first person from the standpoint of a character with autism.

Sunday, December 02, 2007

The Elusive Phillips Curve

Nobelist George Akerlof once said, "Probably the single most important macroeconomic relationship is the Phillips curve." Unfortunately, it is a relationship that we still don't fully understand. The San Francisco Fed offers a nice summary of where things stand in Fixing the New Keynesian Phillips Curve.

Saturday, December 01, 2007

Forecast Update

About Me

I am the Robert M. Beren Professor of Economics at Harvard University, where I teach introductory economics (ec 10). I use this blog to keep in touch with my current and former students. Teachers and students at other schools, as well as others interested in economic issues, are welcome to use this resource.